Average propensity to consume Definition
What is the average propensity to consume?
The average propensity to consume (APC) measures the percentage of income that is spent rather than saved. It can be calculated by a single person who wants to know where the money is going or by an economist who wants to track the spending and saving habits of an entire nation.
In both cases, the propensity to consume can be determined by dividing average household consumption, or expenditure, by average household income, or earnings.
Key points to remember
- Income, whether individual or national, must be spent or saved.
- The average propensity to consume is the percentage of income spent, while the average propensity to save is the percentage of income saved.
- A higher average propensity to consume signals greater economic activity as consumers demand goods and services.
- Alternatively, a lower average propensity signals a slowing economy, as fewer goods are needed and job stability is threatened.
- The average propensity to consume is most informative when tracked over time or compared across nations or individuals.
Understanding the average propensity to consume
From a broader economic perspective, a high average propensity to consume is generally good for the economy. When the average propensity to consume is high, consumers save less and spend more on goods or services. This increased demand stimulates economic growth, business expansion and employment at large.
Low-income households are often considered to have a higher average propensity to consume than high-income households. Low-income households may be forced to spend all of their income on necessities with minimal disposable income remaining to save. Alternatively, higher income households with higher cash flows once their needs are met generally have a relatively lower average propensity to consume.
Economists often assess economic forecasts on the stocks of middle-income households. The spending and saving habits of this demographic group often indicate a degree of confidence or pessimism about their personal financial situation and the economy as a whole.
When annotated as a decimal, the average propensity to consume ranges from zero to one. At zero (or 0%), all income is saved. At one (or 100%), all income is consumed.
Propensity to consume vs propensity to save
The sum of the average propensity to consume and the average propensity to save is always equal to one. A household or nation must either spend or save all of its income.
The inverse of the average propensity to consume is the average propensity to save (APS). This figure is simply total income minus expenses. The result is known as the savings rate.
Notably, the savings rate is normally based on its percentage of disposable income, or after-tax income. A person determining their personal propensities to consume and save should probably also use the disposable income figure for a more realistic measure.
Example of average propensity to consume
Suppose a country’s economy has a gross domestic product (GDP) equivalent to its disposable income of $500 billion for the previous year. Total savings to the economy were $300 billion, and the rest was spent on goods and services.
The country’s APS is calculated at 0.60, or $300 billion/$500 billion. This indicates that the economy has spent 60% of its disposable income on savings. The average propensity to consume is calculated as 0.40, or (1 – 0.60). Consequently, the nation spent 40% of its GDP on goods and services.
APS can include saving for retirement, buying a home, and other long-term investments. As such, it can be an indicator of national financial health.
According to the Bureau of Economic Analysis, the average household in the United States saved 6.2% of their disposable income in March 2022. That’s more than 2% less than three months ago.
The marginal propensity to consume (MPC) is a related concept. It measures the evolution of the average propensity to consume.
Suppose the nation in the previous example has increased its GDP to $700 billion and its consumption of goods and services has increased to $375 billion. The economy’s average propensity to consume rose to 53.57%.
National consumption increased from $200 billion to $375 billion. Alternatively, the country’s GDP rose from $500 billion to $700 billion. The country’s marginal propensity to consume is 87.5% ($375 billion – $200 billion) / ($700 billion – $500 billion). Marginal propensity measures the directional tendency of how an entity uses its money. In this case, 87.5% of the new growth has been consumed.
What is the average propensity to consume?
The average propensity to consume is an economic indicator of the amount of income spent. A specific entity is selected, such as an individual, an income class, or an entire country. The average propensity to consume measures how much money is saved versus spent.
The average propensity to consume is used by economists to predict future economic growth. When the average propensity to consume is higher, more people spend more money. This stimulates economic growth through product demand and job creation.
How do we measure the average propensity to consume?
The average propensity to consume can be expressed as a percentage (60% of income is consumed) or as a decimal (average consumption is 0.6). The average propensity to consume is also generally more useful when compared to itself over time or between entities. For example, the average propensity to consume of a US citizen could be tracked over time or compared to that of Canadian citizens.
How to calculate the average propensity to consume?
The average propensity to consume is calculated by dividing an entity’s consumption by the entity’s total income. It is a ratio between what is spent and what is earned.
What does the average propensity to consume mean?
The average propensity to consume is an economic measure of the income spent by a specific entity. This entity can be an individual or a country. If an entity has a higher average propensity to consume, it means that a greater proportion of its income is used to buy things rather than to save for the future.